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Tencent’s Third Quarter Growth Should Scare the Bears

The tech giant crushes earnings estimates with one hand tied behind its back.

Tencent(NASDAQOTH:TCEHY) was one of China's hottest tech stocks in 2017, more than doubling in value on the growth of its social media and gaming businesses. But this year escalating trade tensions and a freeze on new gaming approvals reduced its market value by nearly a third.

The bears pounced on Tencent, claiming that the gaming freeze and competition from large rivals like Alibaba(NYSE:BABA) and start-ups like ByteDance would cause its growth to decelerate and its margins to contract. However, Tencent's third quarter earnings report counters many of those bearish arguments.

On a non-GAAP basis, which excludes investments and other one-time losses and gains, Tencent's net income grew 15% to 19.7 billion RMB ($2.9 billion). Here's how those results compare to Tencent's previous quarters:

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Revenue

51%

48%

30%

24%

GAAP Net income

98%

61%

(2%)

30%

Non-GAAP Net income

42%

29%

20%

15%

YOY growth. Source: Tencent quarterly reports.

Tencent's revenue growth fell to its lowest level in three years, but that wasn't surprising since its online gaming business -- which generated 32% of its revenues during the quarter -- remains crippled by the temporary suspension of new game approvals in China. But despite those challenges, Tencent's operating margin held steady year-over-year at 35%, and its profit growth accelerated again.

The gaming business treads water

Its smartphone gaming revenue rose 7% annually and 11% sequentially, buoyed by the popularity of Honor of Kings, the top mobile game in China; PUBG Mobile, which remains a top mobile game in overseas markets; and the launch of ten third-party games that were approved prior to the freeze. Tencent is also still sitting on a pipeline of 15 other games with monetization approval.

That growth counters the claim that Tencent's smartphone gaming business is doomed, and indicates that it could tread water with those titles until the approval process restarts. Recent reports indicate that the freeze could end in early 2019.

Unfortunately, Tencent's PC gaming revenues fell 15% annually and 4% sequentially due to a lack of new games and gamers shifting toward mobile devices. However, that ailing business could be revived next year if the government approves the monetization of PUBG, Fortnite, and Monster Hunter World.

Fortnite. Image source: Epic Games.

Growth in social networking, advertising, and subscriptions

Tencent's WeChat, the top mobile messaging app in China, grew its monthly active users (MAUs) by 10.5% annually and 2.3% sequentially to 1.08 billion. It's keeping users locked into that ecosystem with "mini programs" that provide in-app services like shopping, ride hailing, and deliveries. The platform now hosts over 1 million mini programs that reach 200 million daily active users (DAUs).

Those mini programs, along with Weixin Moments, QQ KanDian, and its mobile advertising network, boosted its "social media and others" ad revenue 61% annually to 11.2 billion RMB. Meanwhile, its media ad revenues rose 23% to 5.1 billion RMB thanks to ads on streaming videos and other digital content. Its total online ad revenues rose 47% and accounted for a fifth of Tencent's top line.

Tencent is also generating fresh revenues from VAS (value-added services) subscriptions for services like Tencent Video and Tencent Music. Its total VAS subscriptions rose 23% annually to 154 million, and its video subscriptions jumped 79% to 82 million. Its total social media revenue -- which includes those VAS subscriptions -- rose 19% annually to 18.2 billion RMB and accounted for 23% of its top line.

Battling Alibaba in cloud services and payments

Lastly, Tencent's "other" revenues -- which mainly come from its cloud and payment services -- rose 69% to 20.3 billion RMB and accounted for a quarter of Tencent's top line.

Tencent didn't disclose exactly how much cloud revenue it generated during the quarter, but it disclosed that its cloud revenue over the past three quarters more than doubled year-over-year to 6 billion RMB. That sounds impressive, but Alibaba's cloud services revenue rose 90% annually to 5.7 billion RMB last quarter -- which indicates that Tencent's cloud business is still much smaller than Alibaba's.

As for its payment services, Tencent's WeChat Pay retained its lead over Ant Financial's Alipay in terms of MAUs and DAUs. Transaction volumes on the platform grew 50% annually, with offline daily commercial transactions surging 200%.

Why the bears should be scared

Over two-thirds of Tencent's revenue now comes from non-gaming businesses, and those businesses are all generating impressive growth. Looking ahead, several major catalysts -- including new gaming approvals, a potential trade deal, Tencent Music's IPO, and the growth of its digital subscription, cloud, and payments revenues (which are now prioritized by its recent restructuring) -- could help the stock rebound in 2019.

Author

Leo is a Tech and Consumer Goods Specialist who has covered the crossroads of Wall Street and Silicon Valley since 2012. His wheelhouse includes cloud, IoT, analytics, telecom, and gaming related businesses. Follow him on Twitter for more updates!